Blockchain and smart contracts: where do we stand today?

Written on 22 Nov 2019

The European Union Blockchain Observatory and Forum issued its first report analysing this new technology and how it fits along with smart contracts, within the current regulatory framework. In this article, we analyse this organisation's functions, the implications of this report and the future challenges this matter arises.

Although there is not a consensus for the definition of the blockchain concept , this expression is used, in general terms, to refer to databases distributed in the form (precisely) of blockchains, designed to prevent any modifications using an encryption system and linking information with the other blocks. In other words, blockchain allows the transfer of data digitally through a very sophisticated coding system and in a seemingly secure way.

Even though at first blockchain was developed to support the design and development of Bitcoin, the truth is that its scope of application goes beyond that. Due to its great potential, other applications were generated for its use such as smart contracts or others not as well known, such as data registration and verification (used in clinics and hospitals or for the registration of property or vehicles), since one of the characteristics of blockchain is that it can be used to store any type of information, resulting in an unalterable record.

In 2018, after acknowledging the implications that this technology can have on the industry and obtaining the support of the European Parliament, the European Commission launched the creation of the European Union Blockchain Observatory and Forum, whose objective is to accelerate the development of the blockchain ecosystem within the European Union. Thus, the Observatory formed two working groups composed of experts in the field in order to create discussion forums, exchange information and opinions and make recommendations. With this, the European Union aims to be a source of knowledge in blockchain innovation, as a leader in an area in which there are still many aspects to be defined.

For this reason, the Observatory issued its first report "Legal and Regulatory Framework of Blockchains and Smart Contracts", addressing (as inferred from the title) aspects related to blockchain technology, smart contracts, their current regulation and the challenges they raise.

In the report, the Observatory identifies, among others, what aspects should be taken into account by the authorities and regulatory bodies to overcome the difficulties that come with blockchain. One of the major issues presented is whether the existing legal and regulatory framework (with some changes) will be sufficient to accommodate said technology (and what derives from it) or if it will be necessary to draft new laws to meet the standards of this new technology. To address this issue and although it is a question for which there is still no clear answer today, the report contains eight guiding principles to aid policy makers and institutions in dealing with blockchain legal issues. These principles include drafting simple yet usable definitions of the concepts of blockchain and smart contracts, promote cross-border cooperation (by exchanging, for example, the legal interpretations made by the different Member States regarding issues related to this matter), choose the right regulatory approach, harmonise the law and interpretations of it and help organisations and policy makers develop and understanding this technology.

The report also addresses other aspects related to blockchain technology that have been a source of controversy. Among them, the legality of the transactions registered in blockchain, as well as the problems generated by the decentralisation of this system, with special emphasis on the difficulty of assigning responsibilities to the different participants. As noted in the previous paragraph, this highlights the need to harmonise regulations in this area. In relation to this aspect, the report identifies "access points" that the authorities could use to identify the users carrying out transactions in blockchain (such as internet service providers or software developers). Since many of these transactions are carried out under pseudonyms or even anonymously, the European Union wants to prevent this area from being free of regulation and where none of the participating users assume responsibility. In general, the report focuses on issues related to liability for breach of law or damages in relation to activities carried out using blockchain technology. Likewise, the report also studies the implications that this matter has in other areas, such as data protection and unfair competition.

The report also deals with smart contracts, which are contracts that have the ability to be executed automatically because, in short, they are computer programs that are programmed (like any other software) to carry out a task or a series of tasks in accordance with the instructions previously given. This program contains a series of instructions stored in a blockchain network, so that if a series of actions occurs, certain events take place (if "A" happens, then event "B" will take place). Among other innovative elements, smart contracts also bring autonomy, meaning they do not need any intermediaries to guarantee their execution, resulting in reduction of time and costs. The report's section dedicated to this type of contracts highlights the difference established by the Observatory between "smart legal contracts" (smart contracts, as we know them) and "smart contracts with legal implications". Regarding the latter, the Observatory analyses the different uses that smart contracts can have besides being configured as an agreement between parties, and references the case of Decentralised Autonomous Organisations (DAOs), which are entities that make decisions electronically by means of a coded rules system (that is, a computer code), which defines what actions the organisation will take.

In summary and while the European Union seems to be clear about its commitment to blockchain technology, it is also aware that, undoubtedly, this technology raises challenges and a large number of legal issues. As a result, this report aims to guide and advise the different Member States on this topic, in order to establish, among all, regulations that are capable of offering legal certainty to all participants, both individuals and entities, in such a way that it generates sufficient confidence to make use of the opportunities that this technology offers.